**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

----

 

**FORM 10-Q**

 
| **ý**                                              | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------|----------------------------------------------------------------------------------------------------|
| ** **                                              | ** **                                                                                         |
| **For the Quarterly Period Ended March 31,  2005** |
| ** **                                              | ** **                                                                                         |
| **o**                                                   | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from         to        **

 

**Commission file number:  0-25323**

 

| **ALBANY MOLECULAR RESEARCH, INC.**                                                 |
|-------------------------------------------------------------------------------------|
| (Exact name of registrant as specified in  its charter)                             |
|                                                                                |   |   |
| **DELAWARE**                                                                        | ** ** | **14-1742717** |
| (State or other jurisdiction of  incorporation or organization)                     |   | (I.R.S. Employer  Identification No.) |
|                                                                                |   |   |
| **21 Corporate Circle  PO Box 15098  Albany, New York  12212-5098**            |
| (Address of principal executive offices)                                            |
|                                                                                |
| **(518) 464-0279**                                                                  |
| (Registrant’s telephone number, including  area code)                          |
|                                                                                |   |   |
| **N/A**                                                                             |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

| Yes |   | ý |   | No |   | o |
|-----|--------|--------|--------|----|--------|---|

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2).

 

| Yes |   | ý |   | No |   | o |
|-----|--------|--------|--------|----|--------|---|

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| **Class**                     | ** ** | **Outstanding at May 2, 2005** |
|-------------------------------|------------|--------------------------------|
| Common  Stock, $.01 par value |       | 32,270,019                     |

 

 

----

 

ALBANY MOLECULAR RESEARCH, INC.

Quarterly Report on Form 10-Q For the Period Ended March 31, 2005

INDEX

 
| Part I.    | Financial Information |                                                                                        |
|------------|-----------------------|---------------------------------------------------------------------------------------------|
|       |                  |                                                                                        |   |
|       | Item 1.               | Condensed Consolidated Financial Statements  (Unaudited)                                    |   |
|       |                  |                                                                                        |   |
|       |                  | Condensed  Consolidated Statements of Income                                                |   |
|       |                  |                                                                                        |   |
|       |                  | Condensed  Consolidated Balance Sheets                                                      |   |
|       |                  |                                                                                        |   |
|       |                  | Condensed  Consolidated Statements of Cash Flows                                            |   |
|       |                  |                                                                                        |   |
|       |                  | Notes to Condensed Consolidated Financial Statements                                        |   |
|       |                  |                                                                                        |   |
|       | Item 2.               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|       |                  |                                                                                        |   |
|       | Item 3.               | Quantitative  and Qualitative Disclosures About Market Risk                                 |   |
|       |                  |                                                                                        |   |
|       | Item  4.              | Controls and  Procedures                                                                    |   |
|       |                  |                                                                                        |   |
| Part II.   | Other Information     |                                                                                        |
|       |                  |                                                                                        |   |
|       | Item 1.               | Legal Proceedings                                                                           |   |
|       |                  |                                                                                        |   |
|       | Item 6.               | Exhibits                                                                                    |   |
|       |                  |                                                                                        |   |
| Signatures |                  |                                                                                        |

 

2

----

 

PART I —FINANCIAL INFORMATION

 

Item 1.             CondensedConsolidated Financial Statements

 

**AlbanyMolecular Research, Inc.**

 

**CondensedConsolidated Statements of Income**

**(unaudited)**

 

*(Dollars in thousands, except for per share data)*

 
| ** **                                  | ** ** | **Three Months Ended**  | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
|                                        |       |                    |       |   |   |
| Contract revenue                            |       | $                       | 36,627     |   | $ | 30,814 |   |
| Recurring royalties                         |       | 12,007                  |       | 9,992 |   |
| Total revenue                               |       | 48,634                  |       | 40,806 |   |
|                                        |       |                    |       |   |   |
| Cost of contract revenue                    |       | 29,136                  |       | 23,863 |   |
| Technology incentive award                  |       | 1,201                   |       | 998 |   |
| Research and development                    |       | 3,489                   |       | 7,880 |   |
| Selling, general and administrative         |       | 6,452                   |       | 3,921 |   |
| Total operating expenses                    |       | 40,278                  |       | 36,662 |   |
|                                        |       |                    |       |   |   |
| Income from operations                      |       | 8,356                   |       | 4,144 |   |
|                                        |       |                    |       |   |   |
| Other income (expense):                     |       |                    |       |   |   |
|                                        |       |                    |       |   |   |
| Equity in loss of unconsolidated affiliates |       | —                  |       | (65 | ) |
| Interest income, net                        |       | 200                     |       | 161 |   |
| Other income, net                           |       | 3                       |       | 8 |   |
|                                        |       |                    |       |   |   |
| Total other income (expense):               |       | 203                     |       | 104 |   |
|                                        |       |                    |       |   |   |
| Income before income tax expense            |       | 8,559                   |       | 4,248 |   |
|                                        |       |                    |       |   |   |
| Income tax expense                          |       | 2,962                   |       | 1,487 |   |
|                                        |       |                    |       |   |   |
| Net income                                  |       | $                       | 5,597      |   | $ | 2,761 |   |
|                                        |       |                    |       |   |   |
| Basic earnings per share                    |       | $                       | 0.18       |   | $ | 0.09 |   |
|                                        |       |                    |       |   |   |
| Diluted earnings per share                  |       | $                       | 0.17       |   | $ | 0.09 |   |

 

*See notes to unaudited condensed consolidated financial statements.*

 

3

----

 

**Albany Molecular Research, Inc.**

**Condensed ConsolidatedBalance Sheets**

 

*(Dollars and share amounts in thousands)*

 
| ** **                                                                                                                                                  | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                  | ** ** | **(unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                  |       |                     |       |                        |       |
| Current assets:                                                                                                                                             |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                   |       | $                        | 47,069     |                        | $          | 41,171 |   |
| Investment securities, available-for-sale                                                                                                                   |       | 91,404                   |       | 92,578                      |       |
| Accounts receivable, net                                                                                                                                    |       | 20,216                   |       | 14,263                      |       |
| Royalty income receivable                                                                                                                                   |       | 12,005                   |       | 12,178                      |       |
| Inventory                                                                                                                                                   |       | 32,211                   |       | 32,415                      |       |
| Prepaid expenses and other current assets                                                                                                                   |       | 3,827                    |       | 3,914                       |       |
| Property and equipment held for sale                                                                                                                        |       | 5,627                    |       | 5,627                       |       |
| Total current assets                                                                                                                                        |       | 212,359                  |       | 202,146                     |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Property and equipment, net                                                                                                                                 |       | 143,962                  |       | 145,753                     |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Other assets:                                                                                                                                               |       |                     |       |                        |       |
| Goodwill                                                                                                                                                    |       | 25,747                   |       | 25,747                      |       |
| Intangible assets and patents, net                                                                                                                          |       | 1,239                    |       | 1,201                       |       |
| Equity investments in unconsolidated affiliates                                                                                                             |       | 956                      |       | 956                         |       |
| Other assets                                                                                                                                                |       | 1,177                    |       | 1,089                       |       |
| Total other assets                                                                                                                                          |       | 29,119                   |       | 28,993                      |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Total assets                                                                                                                                                |       | $                        | 385,440    |                        | $          | 376,892 |   |
|                                                                                                                                                        |       |                     |       |                        |       |
| **Liabilities and Stockholders’ Equity**                                                                                                               |       |                     |       |                        |       |
| Current liabilities:                                                                                                                                        |       |                     |       |                        |       |
| Accounts payable and accrued expenses                                                                                                                       |       | $                        | 14,591     |                        | $          | 14,289 |   |
| Deferred revenue                                                                                                                                            |       | 2,513                    |       | 2,089                       |       |
| Accrued pension benefits                                                                                                                                    |       | 631                      |       | 631                         |       |
| Income taxes payable                                                                                                                                        |       | 3,126                    |       | 846                         |       |
| Current installments of long-term debt                                                                                                                      |       | 30,072                   |       | 4,526                       |       |
| Total current liabilities                                                                                                                                   |       | 50,933                   |       | 22,381                      |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Long-term liabilities:                                                                                                                                      |       |                     |       |                        |       |
| Long-term debt, excluding current installments                                                                                                              |       | 21,983                   |       | 48,603                      |       |
| Deferred income taxes                                                                                                                                       |       | 7,671                    |       | 6,997                       |       |
| Pension and postretirement benefits                                                                                                                         |       | 2,885                    |       | 3,139                       |       |
| Other long term liabilities                                                                                                                                 |       | 271                      |       | 296                         |       |
| Total liabilities                                                                                                                                           |       | 83,743                   |       | 81,416                      |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Commitments and contingencies                                                                                                                               |       |                     |       |                        |       |
|                                                                                                                                                        |       |                     |       |                        |       |
| Stockholders’ equity:                                                                                                                                  |       |                     |       |                        |       |
| Common stock, $0.01 par value, 100,000 shares  authorized, 34,314 shares issued at March 31, 2005, and 33,942 shares  issued at December 31, 2004 |       | 343                      |       | 340                         |       |
| Additional paid-in capital                                                                                                                                  |       | 192,506                  |       | 189,608                     |       |
| Unearned compensation – restricted stock                                                                                                               |       | (2,235                   | )          | —                      |       |
| Accumulated other comprehensive loss                                                                                                                        |       | (159                     | )          | (117                        | )          |
| Retained earnings                                                                                                                                           |       | 148,413                  |       | 142,816                     |       |
|                                                                                                                                                        |       | 338,868                  |       | 332,647                     |       |
| Less, treasury shares at cost, 2,077 shares                                                                                                                 |       | (37,171                  | )          | (37,171                     | )          |
| Total stockholders’ equity                                                                                                                             |       | 301,697                  |       | 295,476                     |       |
| Total liabilities and stockholders’ equity                                                                                                             |       | $                        | 385,440    |                        | $          | 376,892 |   |
|                                                                                                                                                             |            |                          |            |                             |            |  |  |  |

 

*Seenotes to unaudited condensed consolidated financial statements.*

 

4

----

 

**AlbanyMolecular Research, Inc.**

 

**CondensedConsolidated Statements of Cash Flows**

**(unaudited)**

 

*(Dollars in thousands)*

 
| ** **                                                                         | ** ** | **Three Months Ended**  | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
| ** **                                                                         | ** ** | ** **              | ** ** | ** ** | ** ** |
| **Operating  activities**                                                          |       |                    |       |   |   |
| Net income                                                                         |       | $                       | 5,597      |   | $ | 2,761 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                    |       |   |   |
| Depreciation and amortization                                                      |       | 3,937                   |       | 3,534 |   |
| Allowance for bad debts                                                            |       | (65                     | )          | — |   |
| Warrant Issuance expense                                                           |       | —                  |       | 3,053 |   |
| Equity in earnings of unconsolidated  affiliates                                   |       | —                  |       | 65 |   |
| Deferred income tax expense                                                        |       | 681                     |       | — |   |
|                                                                               |       |                    |       |   |   |
| (Increase) decrease in:                                                            |       |                    |       |   |   |
| Accounts receivable                                                                |       | (5,888                  | )          | 3,353 |   |
| Royalty income receivable                                                          |       | 173                     |       | 2,945 |   |
| Inventory, prepaid expenses and other  assets                                      |       | 4                       |       | (1,589 | ) |
| (Decrease) increase in:                                                            |       |                    |       |   |   |
| Accounts payable and accrued expenses                                              |       | 302                     |       | (3,971 | ) |
| Deferred revenue                                                                   |       | 424                     |       | (804 | ) |
| Income tax payable                                                                 |       | 2,280                   |       | 563 |   |
| Other long-term liabilities                                                        |       | (25                     | )          | (7 | ) |
| Pension and postretirement benefits                                                |       | (254                    | )          | (242 | ) |
| Net cash provided by operating activities                                          |       | 7,166                   |       | 9,661 |   |
|                                                                               |       |                    |       |   |   |
| **Investing  activities**                                                          |       |                    |       |   |   |
| Net (purchases) maturities of investment  securities                               |       | (24,919                 | )          | 3,951 |   |
| Proceeds from sales of investment  securities                                      |       | 25,850                  |       | — |   |
| Purchases of property and equipment                                                |       | (1,706                  | )          | (5,797 | ) |
| Payments for patent applications and other  costs                                  |       | (61                     | )          | (19 | ) |
| Net cash used in investing activities                                              |       | (836                    | )          | (1,865 | ) |
|                                                                               |       |                    |       |   |   |
| **Financing  activities**                                                          |       |                    |       |   |   |
| Borrowings on long-term debt                                                       |       | —                  |       | 5 |   |
| Principal payments on long-term debt                                               |       | (1,074                  | )          | (1,069 | ) |
| Proceeds from sale of common stock                                                 |       | 642                     |       | 695 |   |
| Net cash used in financing activities                                              |       | (432                    | )          | (369 | ) |
|                                                                               |       |                    |       |   |   |
| Increase in cash and cash equivalents                                              |       | 5,898                   |       | 7,427 |   |
|                                                                               |       |                    |       |   |   |
| Cash and cash equivalents at beginning of  period                                  |       | 41,171                  |       | 18,187 |   |
|                                                                               |       |                    |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                       | 47,069     |   | $ | 25,614 |   |

 

*See notes to unaudited condensed consolidated financial statements.*

 

5

----

 

**Note 1 – Summary of Operations andSignificant Accounting Policies**

(All amounts in thousands, except per share amounts, unless otherwisenoted)

 

**Nature of Business and Operations**

 

Albany Molecular Research, Inc. (the “Company”) is a leading globalchemistry-based drug discovery and development company focused on applicationsfor new small molecule prescription drugs. The Company conducts research anddevelopment projects and collaborates with many leading pharmaceutical andbiotechnology companies, and is developing new chemistry technology forpotential pharmaceutical products. The Company engages in chemistry research,from lead discovery, optimization and development to commercial manufacturing.As part of its drug discovery strategy, the Company is also producing novelcompound collections and chemical screening collections. In addition to itschemistry research services, the Company also conducts proprietary research anddevelopment to develop new technologies and to discover new lead compounds withcommercial potential. The Company seeks to license these compounds to thirdparties in return for up-front service fees and milestone payments as well asrecurring royalty payments if these compounds are developed into new drugssuccessfully reaching the market.

 

**Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States of America for interim financial information and with theinstructions to Form 10-Q and Rule 10-01 of Regulation S-X.  In accordance with Rule 10-01, the unauditedcondensed consolidated financial statements do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete consolidated financialstatements.  The year-end condensedconsolidated balance sheet data was derived from audited financial statementsbut does not include all disclosures required by accounting principlesgenerally accepted in the United States of America.  In the opinion of management, all adjustments(consisting of normal recurring accruals and adjustments) considered necessaryfor a fair statement of the results for the interim period have beenincluded.  Operating results for thequarter ended March 31, 2005 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2005.  The accompanying unaudited condensedconsolidated financial statements should be read in conjunction with theaudited consolidated financial statements and notes thereto included in ourAnnual Report on Form 10-K for the year ended December 31, 2004.

 

The accompanying unaudited condensed consolidated financial statementsinclude the accounts of Albany Molecular Research, Inc. and its wholly ownedsubsidiaries.  All intercompany balancesand transactions have been eliminated during consolidation.  Assets and liabilities of non-U.S.operations are translated at period-end rates of exchange, and the incomestatements are translated at the average rates of exchange for the period.Gains or losses resulting from translating non-U.S. currency financialstatements are recorded in Other Comprehensive (Loss) Income in theaccompanying 2005 condensed consolidated balance sheet.

* *

***Revised Classification of Certain Securities***

 

EffectiveDecember 31, 2004, we revised the classification of our auction ratemunicipal bonds as marketable securities in current assets. Previously, suchinvestments had been classified as cash and cash equivalents. Accordingly, wehave reflected these securities as marketable securities in the current assets section ofour balance sheets as of March 31, 2005 and December 31, 2004. Wehave also made corresponding adjustments to our statements of cash flows forthe three months ended March 31, 2004 to reflect the gross purchases andsales of these securities as investing activities rather than as a component ofcash and cash equivalents. This reclassification does not affect previouslyreported cash flows from operations or from financing activities in ourpreviously reported statements of cash flows or our previously reportedstatements of operations for any period.

 

Asoriginally reported at December 31, 2003 and March 31, 2004, $29,250and $28,550, respectively of these current investments were classified as cashequivalents on our balance sheets. These investments have been reclassified toshort-term investments from cash and cash equivalents as previously reported.

 

Forthe three months ended March 31, 2004, the change in net cash used ininvesting activities from previously reported amounts related to theseshort-term auction rate securities was $700.

 

**Use of Management Estimates**

 

The preparation of consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, and disclosures of contingent assets andliabilities, at the date of the financial statements, and the reported amountsof revenues and expenses during the reporting period. Actual results can varyfrom these estimates.

 

6

----

 

**Contract Revenue Recognition**

 

The Company’s contract revenue consists primarily of fees earned undercontracts with third-party customers and reimbursed expenses under suchcontracts. The Company also seeks to include provisions in certain contractswhich contain a combination of up-front licensing fees,milestone and royalty payments should the Company’s proprietary technology andexpertise lead to the discovery of new products that reach the market.Reimbursed expenses consist of chemicals and other project specific costs.Generally, the Company’s contracts may be terminated by the customer upon30 days’ to one year’s prior notice, depending on the size of thecontract. The Company analyzes its agreements to determine whether the elementscan be separated and accounted for individually or as a single unit ofaccounting in accordance with EITF No. 00-21, *Revenue Arrangements with Multiple Deliverables* and SAB 104,*Revenue Recognition*. Allocationof revenue to individual elements which qualify for separate accounting isbased on the estimated fair value of the respective elements.

 

The Company generates contract revenue on the following basis:

 

*Full-time Equivalent (FTE).*  An FTE agreement establishes the number ofCompany employees contracted for a project or a series of

projects, the duration of the contractperiod, the price per FTE, plus an allowance for chemicals and other projectspecific costs, which may or may not be incorporated in the FTE rate.Typically, FTE contracts have terms of six months or longer. FTE contractstypically provide for annual adjustments in billing rates for the scientistsassigned to the contract. These contracts involve the Company’s scientistsproviding services on a “best efforts” basis in the development of novelchemistry for customers. There are no fixed deliverables as part of theseservices. As such, the Company recognizes revenue under FTE contracts on amonthly basis as services are performed according to the terms of the contract.

 

*Time and Materials*.  Under a time and materials contract theCompany charges customers an hourly rate plus an allowance for chemicals andother project specific costs. The Company recognizes revenue for time andmaterial contracts based on the number of hours devoted to the projectmultiplied by the customer’s billing rate plus other project specific costsincurred.

 

*Fixed Fee*.  Under a fixed-fee contract the Companycharges a fixed agreed upon amount for a deliverable. Fixed-fee contracts havefixed deliverables upon completion of the project. The Company recognizesrevenue for fixed fee contracts after projects are completed, delivery is madeand title transfers to the customer and collection is reasonably assured.

 

*Up-Front License Fees,Milestone and Royalty Revenue***.** The Company recognizes revenue from up-front non-refundable licensingfees on a straight line basis over the period of the underlying project. TheCompany will recognize revenue arising from a substantive milestone paymentupon the successful achievement of the event, and the resolution of anyuncertainties or contingencies regarding potential collection of the relatedpayment, or if appropriate over the remaining term of the agreement.

 

*Recurring Royalty RevenueRecognition***.**

 

Recurring royalties consist of royalties under a license agreement withSanofi-Aventis based on the worldwide sales of fexofenadine HCl, marketed asAllegra in the Americas and Telfast elsewhere. The Company records royaltyrevenue in the period in which the sales of Allegra/Telfast occur, because wecan reasonably estimate such royalties. Royalty payments from Sanofi-Aventisare due within 45 days after each calendar quarter and are determinedbased on sales of Allegra/Telfast in that quarter.

 

**NaturalProduct and Lead Finding Sample Collections.**

 

As part of the Company’s strategy to provide a comprehensive offeringof natural product and chemical lead finding discovery services andtechnologies to its customers, it has acquired natural product samplecollections and related assets and is producing novel compound libraries andchemical screening collections. The natural product sample collections wereacquired in connection with the 2001 acquisition of New Chemical Entities, Inc.(NCE). For internally developed libraries, the Company is capitalizing the costof internally producing novel compound and screening collections ininventory.  Initial costs to developnovel compound libraries are categorized as research and development expenseuntil such time it becomes probable that a saleable library can be successfullyproduced. As a result, costs for the design, research, and testing of librariesunder development are expensed as incurred. Company research chemists reviewthe results of analytical procedures to determine if the chemical reactionswere completed as expected and the product purity and product yields are withinrequired specifications. This “validation” process determines whether thechemistry is successful and if a saleable product will result. The Company capitalizescosts of production to inventory once the validation process is completed andsuccessful production is reasonably assured. If a core reaction isunsuccessful, the library template is abandoned and no further developmenttakes place.

 

7

----

 

Capitalized costs areamortized over the economic life of the library (estimated at 3 years) at thegreater of (a) the ratio of the product’s current gross revenue to the total ofcurrent and expected gross revenues or (b) the straight-line method computed bydividing the remaining unamortized capitalized cost by the remaining economiclife of the product. The remaining economic life is reassessed at each balancesheet date and changes in estimate, if appropriate, are made to theamortization model.  Amortization oflibrary inventories is included within research and development expense on theconsolidated income statement.  Libraryamortization expense was $304 and $0 for the three months ended March 31,2005 and 2004, respectively.  Inaddition, the Company monitors the carrying value of its natural product andlead finding sample collections for impairment on a quarterly basis.  The Company compares the carrying values ofthese collections to their estimated net realizable fair values, which arebased on estimated future sales of these collections, to determineimpairment.  The Company recognizes animpairment charge for any collection whose carrying value is greater than itsestimated net realizable fair value.

 

**Long-lived Assets**

 

In accordance with the provisions of SFAS 144**,**the Company assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Factors the Company considers important which could trigger an impairment review include, among others, the following:

 

**•**                  a significant change in the extent or manner in which a long-lived asset is being used;

 

**•**                  a significant change in the business climate that could affect the value of a long-lived asset; and

 

**•**                  a significant decrease in the market value of assets.

 

If the Company determines that the carrying value of long-lived assetsmay not be recoverable, based upon the existence of one or more of the aboveindicators of impairment, the Company compares the carrying value of the assetgroup to the undiscounted cash flows expected to be generated by the assetgroup. If the carrying value exceeds the undiscounted cash flows an impairmentcharge is recorded. An impairment charge is recognized to the extent that thecarrying amount of the asset group exceeds their fair value and will reduceonly the carrying amounts of the long-lived assets.  The Company utilizes the assistance of anindependent valuation firm in determining the fair values.

 

**Goodwill**

 

In accordance with the provisions of SFAS 142, the Company performs an annual****assessment of the carrying value of goodwill for potential impairment (or on an interim basis if certain triggering events occur).  A determination of impairment is made based upon the estimated discounted future cash flows of the operations associated with the related reporting unit.**** If goodwill is determined to be impaired in the future the Company would be required to record a charge to its results of operations.  Factors the Company considers important which could result in an impairment include the following:

 

**•**                                       significant underperformance relative to historical orprojected future operating results;

 

**•**                                       significant changes in the manner of our use of the acquiredassets or the strategy for overall business;

 

**•**                                       significant negative industry or economic trends; and

 

**•**                                       market capitalization relative to net book value.

 

The Company willperform the annual goodwill assessment for its reporting units during the thirdquarter of 2005.  If management’sexpectations of future operating results change, or if there are changes toother assumptions, the estimate of the fair value of our reporting units couldchange significantly. Such a change could result in goodwill impairment chargesin future periods, which could have a significant impact on our consolidatedfinancial statements.  Total goodwillrecorded on the Company’s balance sheet at March 31, 2005 was $25,747,including $23,060 of goodwill associated with the Company’s acquisition ofOrganichem, Inc.

 

8

----

 

**StockCompensation:**

 

The Companyapplies the intrinsic value-based method of accounting prescribed by AccountingPrinciples Board (‘‘APB’’) Opinion No. 25, ‘‘Accounting for Stock Issued toEmployees,’’ and related interpretations, in accounting for its fixed planstock options. As such, compensation expense would be recorded only if, on thedate of grant, the current market price of the underlying stock exceeded theexercise price. Any compensation expense would be recognized over the vestingperiod.

 

The following table illustrates the effect on net income and earningsper share if the Company had applied the fair value recognition provisions ofFASB Statement No. 123, *Accounting for Stock-BasedCompensation,*to stock-based employee compensation.

 
| ** **                                                                                                                                          | ** ** | **Three Months Ended March, 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Net Income, as reported                                                                                                                             |       | $                                | 5,597      |   | $ | 2,761 |   |
| Add:   Stock-based employee compensation expense included in reported net  income, net of related tax effects                                  |       | 14                               |       | — |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |       | (698                             | )          | (895 | ) |
| Pro Forma net income                                                                                                                                |       | $                                | 4,913      |   | $ | 1,866 |   |
|                                                                                                                                                |       |                             |       |   |   |
| Earnings per share:                                                                                                                                 |       |                             |       |   |   |
| Basic as reported                                                                                                                                   |       | $                                | 0.18       |   | $ | 0.09 |   |
| Basic pro-forma                                                                                                                                     |       | $                                | 0.15       |   | $ | 0.06 |   |
|                                                                                                                                                |       |                             |       |   |   |
| Diluted as reported                                                                                                                                 |       | $                                | 0.17       |   | $ | 0.09 |   |
| Diluted pro-forma                                                                                                                                   |       | $                                | 0.15       |   | $ | 0.06 |   |

 

**Note 2 –Earnings Per Share**

 

The shares used in the computation of the Company’s basic and dilutedearnings per share are as follows:

 
| ** **                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                     | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Weighted average common shares outstanding                     |       | 31,931                                |       | 31,670 |   |
| Dilutive effect of stock options                               |       | 246                                   |       | 408 |   |
| Dilutive effect of restricted stock                            |       | 6                                     |       | — |   |
| Weighted average common shares outstanding,  assuming dilution |       | 32,183                                |       | 32,078 |   |

 

The Companyhas excluded certain outstanding stock options and warrants from thecalculation of diluted earnings per share for the three months ended March 31,2005 and 2004 because the exercise price was greater than the average marketprice of the Company’s common shares during that period, and as such would beanti-dilutive.  The amount ofanti-dilutive options and warrants outstanding were 2,881 and 2,219 (before theeffects of the treasury stock method) for the periods ended March 31, 2005,and 2004, respectively and are not included in the calculation of weightedaverage common shares outstanding.

 

**Note 3 – Inventory**

 

Inventory consisted of the following at March 31, 2005 and December 31,2004:

 
| ** **                                 | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw materials                              |       | $                        | 4,726      |                        | $          | 4,818 |   |
| Work in process                            |       | 1,375                    |       | 1,273                       |       |
| Finished goods                             |       | 22,734                   |       | 22,644                      |       |
| Libraries, net of accumulated amortization |       | 3,376                    |       | 3,680                       |       |
| Total                                      |       | $                        | 32,211     |                        | $          | 32,415 |   |

 

9

----

 

**Note4 – Restructuring of Mt. Prospect**

 

OnMay 4, 2004 the Company announced its plan to consolidate operations byrelocating its Mt. Prospect facility operations to its facilities in New York.The Company’s proprietary biocatalysis technology platform, drug metabolismscreening, research fermentation and chemical development technologies in Mt.Prospect have been relocated to New York and continue to be fully integratedwith the Company’s drug discovery and development technologies. Therestructuring resulted in the closure of the Mt. Prospect Research Center inthe fourth quarter of 2004. The consolidation was initiated as a result of alack of anticipated growth in the Company’s chemical development services atthe facility. As a result of the restructuring, 33 employees were terminatedand 25 employees were relocated to facilities in New York.

 

Therestructuring liabilities are included in accounts payable and accrued expenseson the accompanying balance sheets. The following table displays therestructuring activity and liability balances:

 
| ** **           | ** ** | **Balance at  December 31,  2004** | ** ** | **Charges** | ** ** | **Payments** | ** ** | **Balance at  March 31,  2005** | ** ** |
|----------------------|------------|----------------------------------------------|------------|-------------|------------|--------------|------------|-------------------------------------------|------------|
| Termination benefits |       | $                                            | 129        |        | $          | (65          | )          | $                                         | (64        | ) | $ | — |   |
| Asset disposal costs |       | 513                                          |       | —      |       | —       |       | 513                                       |       |
| Total                |       | $                                            | 642        |        | $          | (65          | )          | $                                         | (64        | ) | $ | 513 |   |

 

Costsof termination benefits relate to severance packages, outplacement services andcareer counseling for employees affected by the restructuring. Asset disposalcosts relate primarily to brokerage commissions, legal fees, and marketingexpenses associated with the planned sale of the Mount Prospect Research Centerfacility, which is included in property and equipment held for sale on theconsolidated balance sheet.

 

The Company also incurred$158 in employee and equipment relocation costs during the first quarter of2005.  These relocation costs areincluded under the caption “selling, general and administrative” in the condensedconsolidated statement of operations.

 

Weare currently marketing the Mt. Prospect Research Center facility for sale. Thefacility qualified for held for sale treatment in accordance with SFASNo. 144 during the fourth quarter of 2004. The long-lived assetsassociated with Mt. Prospect have been segregated to a separate line item onthe condensed consolidated balance sheet until they are sold and depreciationexpense has ceased with respect to those assets. We anticipate the completionof the sale of the facility by June 2006.

 

Theabove restructuring activity was recorded exclusively in the AMR operatingsegment. The net cash outflow related to the restructuring for the three monthsended March 31, 2005 was $64.  Anticipatedcash outflows related to the restructuring for the remainder of 2005 is $513,which primarily consists of the payment of accrued asset disposal costs.

 

**Note 5 – Goodwill and Intangible Assets**

 

Thecarrying amounts of goodwill, by segment, as of March 31, 2005 and December 31,2004 are as follows:

 
| **AMR** | ** ** | **Organichem** | ** ** | **Total** | ** ** |
|---------|------------|----------------|------------|-----------|------------|
| $       | 2,687      |           | $          | 23,060    |       | $ | 25,747 |   |
|         |            |                |            |           |            |  |  |  |

 

The components ofintangible assets are as follows:

 
| ** **                   | ** ** | **Cost**   | ** ** | **Accumulated  Amortization** | ** ** | **Net**    | ** ** | **Amortization  Period** | ** ** |
|------------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|--------------------------|------------|
| **March 31, 2005**      | ** ** | ** ** | ** ** | ** **                    | ** ** | ** ** | ** ** | ** **               | ** ** |
| Patents and Licensing Rights |       | $          | 1,539      |                          | $          | (300       | )          | $                        | 1,239      |   | 16 years |   |
|                         |       |       |       |                          |       |       |       |                     |       |
| **December 31,  2004**  |       |       |       |                          |       |       |       |                     |       |
| Patents and Licensing Rights |       | $          | 1,478      |                          | $          | (277       | )          | $                        | 1,201      |   | 16 years |   |

 

Amortization expenserelated to intangible assets for the three months ended March 31, 2005 and2004 was $23 and $134, respectively.

 

Estimated future annual amortization expense related to intangibleassets is approximately $101 per year through the year ended December 31,2009.

 

10

----

 

**Note 6 -****Defined Benefit and Postretirement Welfare Plan**

 

Organichem previously provided retirement benefits under twonon-contributory defined benefit plans and a non-contributory, unfundedpost-retirement welfare plan. Future benefits under all three plans have beenfrozen.

 

***Components of Net Periodic Benefit Cost***

 
| ** **                         | ** ** | **Pension Benefits**                   | ** ** | **Postretirement  Benefits**           | ** ** |
|------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | **Three Months  Ended March 31,** | ** ** | **Three Months  Ended March 31,** | ** ** |
| ** **                         | ** ** | **2005**                               | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                               |       |                                   |       |                                   |       |   |   |   |   |
| Service Cost                       |       | $                                      | —     |                                   | $          | 44 |   | $ | 11 |   | $ | 9 |   |
| Interest Cost                      |       | 317                                    |       | 299                                    |       | 4 |   | 4 |   |
| Expected return on plan assets     |       | (296                                   | )          | (282                                   | )          | — |   | 0 |   |
| Amortization of prior service cost |       | —                                 |       | —                                 |       | — |   | 0 |   |
| Recognized net (gain) loss         |       | —                                 |       | 1                                      |       | — |   | 0 |   |
| Net periodic benefit cost          |       | $                                      | 21         |                                   | $          | 62 |   | $ | 15 |   | $ | 13 |   |

 

***Employer Contributions***

 

The Company previously disclosed in its financial statement for theyear ended December 31, 2004 that it expected to contribute $631 to itspension plan in 2005.  As of March 31, 2005, $294 in contributions have been made.  The Company continues to anticipatecontributing the additional $337 to fund its pension plan in 2005.

 

**Note 7 - Restricted Stock**

 

InMarch 2005, the Compensation Committee of the Board of Directors granted anaward of 267 restricted shares of common stock to employees of the Companyunder the 1998 Stock Option and Incentive Plan.  The shares are issued asrestricted stock and are held in the custody of the Company until all vestingrestrictions are satisfied.  Shares vest under this grant over a period offive years, with 60% vesting after three years of continuous employment fromthe grant date and an additional 20% vesting after four and five years ofcontinuous employment from the grant date, respectively.  If the vesting terms under which the award wasgranted are not satisfied, the shares are forfeited.  Unearned compensation of $2,259 was recordedat the date of award, based on the market value of the shares on the grant date,and is included as a separate component of shareholders’ equity and isamortized over the applicable vesting period.  The amount amortized toexpense during the quarter ended March 31, 2005 was approximately $24.

 

**Note 8 – Operating Segment Data**

 

The Company has organizedits sales, marketing and production activities into the Albany MolecularResearch (AMR) and Organichem segments based on the criteria set forth in SFASNo. 131, “Disclosures about Segments of an Enterprise and Related Information”.  The Company’s management relies on aninternal management accounting system to report results of the segments.  The system includes revenue and costinformation by segment.  The Company’smanagement makes financial decisions and allocates resources based on theinformation it receives from this internal system.

 

Albany Molecular Researchincludes activities such as drug lead discovery, optimization, drug developmentand small scale commercial manufacturing. Organichem includes pilot to commercial scale manufacturing of activepharmaceutical ingredients and intermediates and high potency and controlledsubstance manufacturing all of which are in compliance with the Food and DrugAdministration’s (FDA) current Good Manufacturing Practices.  Corporate activities include businessdevelopment and administrative functions, as well as research and development coststhat have not been allocated to the operating segments.

 

11

----

 

The following tablecontains earnings data by operating segment, reconciled to consolidated totalsincluded in the financial statements:

 
| ** **                                          | ** ** | **Contract  Revenue** | ** ** | **Recurring  Royalty  Revenue** | ** ** | **Operating  income (loss)** | ** ** | **Depreciation  and  Amortization** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|---------------------------------|------------|------------------------------|------------|-------------------------------------|------------|
| **For the three months  ended March 31, 2005** |       |                  |       |                            |       |                         |       |                                |       |
| AMR                                                 |       | $                     | 13,598     |                            | $          | 12,007                       |       | $                                   | 12,700     |   | $ | 2,483 |   |
| Organichem                                          |       | 23,029                |       | —                          |       | 4,597                        |       | 1,454                               |       |
| Corporate                                           |       | —                |       | —                          |       | (8,941                       | )          | —                              |       |
| Total                                               |       | $                     | 36,627     |                            | $          | 12,007                       |       | $                                   | 8,356      |   | $ | 3,937 |   |
|                                                |       |                  |       |                            |       |                         |       |                                |       |
| **For the three  months ended March 31, 2004** |       |                  |       |                            |       |                         |       |                                |       |
| AMR                                                 |       | $                     | 14,066     |                            | $          | 9,992                        |       | $                                   | 12,705     |   | $ | 2,092 |   |
| Organichem                                          |       | 16,748                |       | —                          |       | 3,240                        |       | 1,436                               |       |
| Corporate                                           |       | —                |       | —                          |       | (11,801                      | )          | —                              |       |
| Total                                               |       | $                     | 30,814     |                            | $          | 9,992                        |       | $                                   | 4,144      |   | $ | 3,528 |   |

 

The following tablesummarizes other information by segment as of and for the three months ended March 31,2005:

 
| ** **                               | ** ** | **As of and for the three months ended  March 31, 2005** | ** ** |
|------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                               | ** ** | **AMR**                                                       | ** ** | **Organichem** | ** ** | **Total** | ** ** |
|                                     |       |                                                          |       |   |   |   |   |
| Total assets                             |       | $                                                             | 255,167    |   | $ | 130,273 |   | $ | 385,440 |   |
| Goodwill included in total assets        |       | 2,687                                                         |       | 23,060 |   | 25,747 |   |
| Investments in unconsolidated affiliates |       | 956                                                           |       | — |   | 956 |   |
| Capital expenditures                     |       | 722                                                           |       | 984 |   | 1,706 |   |
|                                          |            |                                                               |            |  |  |  |  |  |  |  |

 

The following tablesummarizes other information by segment as of and for the three months ended March 31,2004:

 
| ** **                               | ** ** | **As of and for the three months ended  March 31, 2004** | ** ** |
|------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                               | ** ** | **AMR**                                                       | ** ** | **Organichem** | ** ** | **Total** | ** ** |
|                                     |       |                                                          |       |   |   |   |   |
| Total assets                             |       | $                                                             | 275,069    |   | $ | 118,512 |   | $ | 393,581 |   |
| Goodwill included in total assets        |       | 17,181                                                        |       | 23,060 |   | 40,241 |   |
| Investments in unconsolidated affiliates |       | 2,242                                                         |       | — |   | 2,242 |   |
| Capital expenditures                     |       | 4,193                                                         |       | 1,604 |   | 5,797 |   |
|                                          |            |                                                               |            |  |  |  |  |  |  |  |

 

**Note 9 – Financial Information by CustomerConcentration and Geographic Area**

 

Total contract revenue from AMR’s three largest customers representedapproximately 14%, 11% and 4% of AMR’s total contract revenue for the threemonths ended March 31, 2005, and 13%, 13% and 6% of total contract revenuefor the three months ended March 31, 2004. Total contract revenue from Organichem’s largest customer, GEBiosciences, represented 77% and 78% of Organichem’s total contract revenue forthe three months ended March 31, 2005 and 2004, respectively.  GE Biosciences accounted for approximately 49%and 42% of the Company’s total contract revenue for the three months ended March 31,2005 and 2004, respectively.  GE isexpected to discontinue its purchases of one of the products it receives fromOrganichem after 2005, and is making all of its 2005 purchases in the firsthalf of the year.  Sales of this producttotaled $10,000 in the first quarter of 2005, compared to $3,900 in the firstquarter of 2004.

 

12

----

 

The Company’s total contract revenue for the three months ended March 31,2005 and 2004 was recognized from customers in the following geographicregions:

 
| ** **    | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------|------------|---------------------------------------|------------|
| ** **    | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|          |       |                                  |       |   |   |
| United States |       | 49                                    | %          | 56 | % |
| Europe        |       | 50                                    | %          | 40 | % |
| Other         |       | 1                                     | %          | 4 | % |
|          |       |                                  |       |   |   |
| Total         |       | 100                                   | %          | 100 | % |

 

**Note 10 – Comprehensive Income**

** **

The Company is required to report comprehensive income and itscomponents in accordance with the provisions of the Financial AccountingStandards Board Statement No. 130, “Reporting Comprehensive Income.”

 

The following table presents the components of the Company’scomprehensive income for the three months ended March 31, 2005 and 2004:

 

*(in thousands)*

 
| ** **                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                            |       |                                  |       |   |   |
| Net income                                                      |       | $                                     | 5,597      |   | $ | 2,761 |   |
|                                                            |       |                                  |       |   |   |
| Other comprehensive loss:                                       |       |                                  |       |   |   |
| Unrealized loss on available-for-sale  securities, net of taxes |       | (126                                  | )          | (43 | ) |
| Unrealized gain (loss) on Interest Rate  Swap, net of taxes     |       | 115                                   |       | (182 | ) |
| Foreign currency translation loss                               |       | (31                                   | )          | — |   |
|                                                            |       |                                  |       |   |   |
| Total comprehensive income                                      |       | $                                     | 5,555      |   | $ | 2,536 |   |

 

**Note 11– Legal Proceedings**

 

TheCompany, from time to time, may be involved in various claims and legalproceedings arising in the ordinary course of business.

 

AMRTechnology, a subsidiary of the Company, along with Aventis PharmaceuticalsInc., a U.S. pharmaceutical business of Sanofi-Aventis S.A., are involved inlegal proceedings with several companies seeking to market generic versions ofAllegra. Beginning in 2001, Barr Laboratories, Inc., ImpaxLaboratories, Inc., Mylan Pharmaceuticals, Inc., Teva PharmaceuticalsUSA, Dr. Reddy’s Laboratories, Ltd./Dr. Reddy’sLaboratories, Inc., Ranbaxy Laboratories Ltd./Ranbaxy PharmaceuticalsInc., and Sandoz Inc. filed Abbreviated New Drug Applications (ANDAs) with theU.S. Food and Drug Administration, or FDA, to produce and market genericversions of Allegra products.

 

Inresponse to the filings described above, beginning in 2001, AventisPharmaceuticals filed patent infringement lawsuits against Barr Laboratories,Impax Laboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Ranbaxy Laboratories Ltd./RanbaxyPharmaceuticals Inc., and Sandoz. Each of the lawsuits was filed in the U.S.District Court in New Jersey and alleges infringement of one or more patentsowned by or licensed to Aventis Pharmaceuticals. Further, beginning in March 5,2004, AMR Technology, along with Aventis Pharmaceuticals, filed suit in theU.S. District Court in New Jersey against Barr Laboratories, ImpaxLaboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Amino Chemicals, Ltd., Sandoz, Inc. and Ranbaxy LaboratoriesLtd./Ranbaxy Pharmaceuticals Inc., asserting infringement of two of our U.S.patents that are exclusively licensed to Aventis Pharmaceuticals relating toAllegra and Allegra-D products.

 

13

----

 

Inthe pending litigations, Aventis Pharmaceuticals and AMR Technology have enteredinto covenants not to sue the defendants under U.S. Patent No. 5,578,610,which patent has not been asserted in the litigation but which AventisPharmaceuticals exclusively licenses from us. However, we and AventisPharmaceuticals have agreed that Aventis Pharmaceuticals will continue to payroyalties to us based on that patent under our original license agreement withAventis Pharmaceuticals. Under our arrangements with Aventis Pharmaceuticals,we will receive royalties until expiration of the underlying patents (2013 forU.S. Patent No. 5,578,610 and 2015 for U.S. Patent No. 5,750,703)unless the patents are earlier determined to be invalid.

 

Under applicable federal law, marketing of an FDA-approved genericversion of Allegra may not commence until the earlier of a decision favorableto the generic challenger in the patent litigation or 30 months after the datethe patent infringement lawsuit was filed. In general, the first generic fileris entitled to a 180-day marketing exclusivity period upon FDA approval.  Barr Laboratories, Inc., a defendant in the ongoingAllegra patent litigation, currently is eligible to market a generic form ofAllegra; but, if it were to do so, it would risk damages for patentinfringement if the current Allegra patent litigation is not resolved favorablyto it.

 

**Note 12- Recently Issued Accounting Pronouncements**

 

InNovember 2004, the FASB issued Statement No. 151, *InventoryCosts – an Amendment of ARB No. 43, Chapter 4,*to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage). This Statement requires that those items be recognized as current-periodcharges regardless of whether they meet the criterion of “so abnormal” asdefined in ARB No. 43.  In addition, thisStatement requires that allocation of fixed production overheads to the costsof conversion be based on the normal capacity of the productionfacilities.  The provisions of thisStatement are effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005, with earlier application permitted.  This Statement applies to the Company for thefiscal year ending December 31, 2006. The Company will assess the impact of applying this Statement in thethird quarter of 2005.

 

InDecember 2004, the FASB issued Statement No. 123 (Revised), *Share-Based Payment (Revised)*, which amends FASB StatementNo. 123, *Accounting for Stock-Based Compensation*,and supersedes APB Opinion No. 25, *Accounting for StockIssued to Employees,*in establishing standards for the accountingfor transactions in which an entity exchanges its equity instruments for goodsor services, as well as transactions in which an entity incurs liabilities inexchange for goods or services that are based on the fair value of the entity’sequity instruments or that may be settled by the issuance of those equityinstruments.  This Statement requiresthat the cost resulting from all share-based payment transactions be recognizedin the financial statements based on fair value of the share-basedpayment.  This Statement establishes fairvalue as the measurement objective in accounting for share-based paymenttransactions with employees, except for equity instruments held by employeeshare ownership plans.  In April 2005,the SEC issued a Final Rule amending Rule4-01(A) of Regulation S-X regarding the compliance date for thisStatement.  This Statement applies to theCompany beginning with the quarter ending March 31, 2006.  The Company expects that as a result ofadopting this Statement that the Company will recognize expense in theconsolidated income statement for the fair value of share options andrestricted stock awards issued to its employees, as well as for the portion ofthe purchase discount on the market price of the Company’s common stock offeredto employees in conjunction with the Company’s Employee Stock Purchase Planthat is considered compensatory based on the guidance in FAS No. 123(R).  The Company has not completed itsdetermination, however, it is expected that the application of this Statementwill have a material impact on the Company’s results of operations.

 

InOctober 2004, the President signed the American Jobs Creation Act of 2004(the “Act”). The Act provides a deduction for income from qualified domestic productionactivities, which will be phased in from 2005 through 2010. In return, the Actalso provides for a two-year phase-out of the existing extra-territorial incomeexclusion (ETI) for foreign sales that was viewed to be inconsistent withinternational trade protocols by the European Union.  In December 2004,the FASB issued Staff Position No. FAS 109-1, *Applicationof FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction onQualified Production Activities Provided by the American Jobs Creation Act of2004.*  This Staff Positionclarifies that the tax deduction for qualified domestic production activitiesprovided by the American Jobs Creation Act of 2004 (the Act) should beaccounted for as a special deduction under FAS 109 as opposed to a tax-ratededuction.  The phase-in of the taxdeduction and the phase-out of the ETI exclusion beginswith qualifying production activities and foreign sales for the year ending December 31,2005.  The Company has included the taximpact of the Act and the impact of applying the Staff Position in itsprovision for income taxes for the quarter ended March 31, 2005.

 

14

----

 

Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

 

**Forward-Looking Statements**

 

The following discussion of our results of operations and financialcondition should be read in conjunction with the accompanying CondensedConsolidated Financial Statements and the Notes thereto included within this report.This quarterly report on Form 10-Q contains “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933, as amended (the “SecuritiesAct”), and Section 21E of the Securities Exchange Act of 1934, as amended(the “Exchange Act”).  These statementsmay be identified by forward-looking words such as “may,” “could,” “should,” “would,”“will,” “intend,” “expect,” “anticipate,” “believe,” and “continue” or similarwords and include, but are not limited to, statements concerning the MountProspect Research Center, pension plan contributions, GE Biosciences, contractrevenue and costs, the ongoing Allegra patent infringement litigation, customerspending and business trends, foreign operations (including Singapore andIndia), clinical supply manufacturing, management’s strategic plans, andresearch and development projects and expenses, selling, general andadministrative expenses and extension of our line of credit.  The Company’s actual results may differmaterially from such forward-looking statements as a result of numerousfactors, some of which the Company may not be able to predict and may not bewithin the Company’s control.  Factorsthat could cause such differences include, but are not limited to, the Company’sability to successfully relocate and consolidate its Mount Prospect operationswith its New York facility, the risk that the Company will not achieve the costsavings expected to result from the closure and relocation of its MountProspect operations, the Company’s ability to recruit and retain experiencedscientists, trends in pharmaceutical and biotechnology companies outsourcingchemical research and development, the loss of a significant customer, sales ofAllegra (including any deviations in estimates provided by Sanofi-Aventis) andthe Company’s receipt of significant royalties from the Allegra licenseagreement, the risk that Allegra may be approved for over-the-counter use andClaritin’s approval for over-the-counter use, the Company’s and Sanofi-Aventis’ability to successfully enforce their respective intellectual property, patentrights and technology, including with respect to the generic companies’Abbreviated New Drug Application filings, the integration and operating risksassociated with the Company’s acquisition of Organichem, the Company’s abilityto successfully develop novel compounds and lead candidates in its researchprograms and collaborative arrangements, the Company’s ability to takeadvantage of proprietary technology and expand the scientific tools availableto it, the ability of the Company’s strategic investments and acquisitions toperform as expected and any goodwill impairment related to such investments andacquisitions, the Company’s ability to successfully complete its ongoing expansionprojects on schedule, the Company’s ability to execute its business plan forcompound and chemical screening libraries, and the Company’s ability toeffectively manage its growth, as well as those discussed in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004 as filedwith the Securities and Exchange Commission on March 16, 2005.  All forward-looking statements are made as ofthe date of this report, and we do not undertake to update any suchforward-looking statements in the future. References to “we,” “us,” and “our,” refers to Albany MolecularResearch, Inc. and its subsidiaries, taken as a whole.

 

**Overview**

 

We are a leading global chemistry-based drug discovery and developmentcompany, focused on identifying and developing novel biologically active smallmolecules with applications in the prescription drug market. We engage incomprehensive chemistry research from lead discovery, optimization anddevelopment to commercial manufacturing and conduct cell and non-cell based highthroughput screening on a variety of biological targets. We perform contractresearch services for many of the leading pharmaceutical and biotechnologycompanies and also conduct our own internal proprietary research anddevelopment to discover new therapeutically-active lead compounds withcommercial potential. We anticipate that we would then license these compoundsto third parties in return for up-front service fees and milestone payments aswell as recurring royalty payments if these compounds are developed into newcommercial drugs. In 1995, our proprietary research and development activitiesled to the development, patenting and licensing of a substantially pure formof, and a manufacturing process for, the active ingredient in the non-sedating antihistaminefexofenadine HCl marketed by Sanofi-Aventis S.A. as Allegra in the Americas andas Telfast elsewhere. In addition, certain of our discovery technologycontracts provide for us to receive milestone and royalty payments fordiscoveries that lead to commercial products.

 

Our total revenue for the quarter ended March 31, 2005 was $48.6 million,including $36.6 million from our chemistry contract business, as comparedto $40.8 million for the quarter ended March 31, 2004.  Contract revenue for the first quarter of2005 increased $5.8 million from $30.8 million in the first quarter of2004.  The increase in contract revenueis primarily due to the timing of delivery requirements for one of the productssold to Organichem’s largest customer, GE Biosciences (GE).  GE is expected to discontinue its purchasesof this product after 2005, and is making all of its 2005 purchases in thefirst half of the year.  Sales of thisproduct totaled $10.0 million in the first quarter of 2005, compared to $3.9million in the first quarter of 2004. We expect the remaining purchases of thisproduct in the second quarter to approximate $7.0 million, with no revenuesassociated with this product after the 2nd quarter of2005. Consolidated gross margin was 20.5% for the quarter ended March 31,2005 compared to 22.6% for the quarter ended March 31, 2004. Gross marginat the AMR operating segment decreased to 21.3% in the first quarter of 2005compared to 26.4% for the same period in 2004, primarily due to the fixed costcomponents of AMRI’s contract business on lower revenues, competitive pricingpressures, and amortization of the Company’s chemical compound and naturalproduct library inventories, partially offset by salary and benefit expensesavings resulting from the closure of the Mt. Prospect facility in the 2nd quarter of 2004.  Gross margin for Organichem in the firstquarter of 2005 was 20.0%, which is consistent with a gross margin of 19.3% inthe first quarter of 2004. 

 

15

----

 

During the quarter ended March 31, 2005, we generated $7.1 million****in cash from operations and spent $1.7 million incapital on our facilities and equipment, primarily related to the expansion ofour manufacturing suites at Organichem. As of March 31, 2005, we had $138.5 million in cash, cashequivalents and investments and $52.1 million in bank and other relateddebt.

 

The business environment for chemistry outsourcing continued to bechallenging in the first quarter of 2005. Our customers continue to spend agreater portion of their research and development dollars on later stagedevelopment projects. This shift in customer focus has resulted in decreaseddemand for our discovery services, which has been partially offset by increasedcontract revenue from chemical development, small-scale GMP manufacturing andanalytical services. In addition, certain areas of our business face foreigncompetition that has substantially lower cost structures. The lower coststructures result from parts of the world where salaries are a fraction of whatthey are in industrialized countries. This trend has resulted in lost businessand has brought pricing pressures in the U.S., impacting our ability toincrease or maintain pricing on our customer contracts.  We continue to pursue our plans to establishlower-cost international operations, including the establishment of ourSingapore Research Centre during the first quarter.  We also expect to begin operations in Indiaduring the second half of 2005. We believe the ability to offer customers achoice of business models and cost structures to meet their drug discoveryneeds will help to strengthen our global competitive advantage. 

 

Total contract revenue from Organichem’s largest customer, GE,represented 77% and 78% of Organichem’s total contract revenue for the quarterended March 31, 2005 and 2004, respectively.  GE accounted for approximately 49% and 42% ofour consolidated contract revenue for the quarter ended March 31, 2005 and2004, respectively.  As noted above, GEis expected to discontinue purchases of one of the products we sell to them inthe third quarter of 2005.  Our objectiveis to recoup the revenues associated with these sales decreases throughincreased sales of another product to GE Biosciences, as well as continuedgrowth in the area of clinical supply manufacturing for advanced stage humantrials.  Clinical supply manufacturingrepresented 14% of Organichem’s total contract revenue for the quarter ended March 31,2005, compared to 3% of total contract revenue for the quarter ended March 31,2004.  We expect the trend of increasedgrowth in clinical supply manufacturing to continue in future periods. 

 

Included in total revenue for the quarter ended March 31, 2005 was$12.0 million in royalties compared to $10.0 million for the quarter ended March 31,2004.  The increase in Allegra royaltiesdirectly corresponds with an increase in worldwide sales of Allegra/Telfast asreported to us by Sanofi-Aventis. 

 

**Resultsof Operations – Three Months Ended March 31, 2005 Compared to Three MonthsEnded March 31, 2004**

 

***Revenues***

 

*Total contract revenue*

 

Contract revenue consists primarily of fees earned under contracts withour third party customers.  Our contractrevenues for each of our AMR and Organichem segments were as follows:

 

| ** **         | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------|------------|---------------------------------------|------------|
| **(in thousands)** | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| AMR                |       | $                                     | 13,598     |   | $ | 14,066 |   |
| Organichem         |       | 23,029                                |       | 16,748 |   |
| Total              |       | $                                     | 36,627     |   | $ | 30,814 |   |

 

AMR contract revenues for the quarter ended March 31 2005,decreased $0.5 million to $13.6 million as compared to $14.1 million for thesame quarter in the prior year.  Thedecrease is a result of continued global competition, pricing pressures andreductions in discovery phase research and development spending bypharmaceutical and biotechnology companies leading to a decrease in demand forour discovery services, partially offset by a combined increase in contractrevenue from chemical development, small-scale GMP manufacturing and analyticalservices as customers continue to focus on development-stage projects.  We see the trends of shifting customerpreference for development-stage projects, global competition and pricingpressures continuing.  We have pursuedstrategies to establish lower-cost international operations in Singapore andIndia.  We established our Singapore ResearchCentre during the first quarter, and expect to begin operations in India duringthe second half of 2005. While the revenue from our international operations isnot expected to be material to consolidated contract revenue in 2005, webelieve the ability to offer customers a choice of business models and coststructures to meet their drug discovery needs will help to strengthen ourcompetitive advantage.  Organichemcontract revenues for the first quarter of 2005 were $23.0 million, an increaseof $6.3 million compared to contract revenue of $16.7 million during the firstquarter of 2004.  Organichem’s contractrevenue increased primarily due to the timing of delivery requirements for oneits products from its largest customer, GE. GE is expected to discontinue its purchases of this product after 2005,and is making all of its 2005 purchases in the first half of the year.  Sales of this product totaled $10.0 millionin the first quarter of 2005, compared to $3.9 million in the first quarter of2004. We expect the remaining purchases of this product in the second quarterto approximate $7.0 million, with no revenues associated with this productafter the 2nd quarter of 2005.

 

16

----

 

Our objective is to recoup the revenues associated with these salesdecreases through increased sales of another product to GE,aswell as continued growth in the area of clinical supply manufacturing foradvanced stage human trials.  Clinicalsupply manufacturing represented 14% of Organichem’s total contract revenue forthe quarter ended March 31, 2005, compared to 3% of total contract revenuefor the quarter ended March 31, 2004. We expect the trend of increased growth in clinical supply manufacturingto continue in future periods.

 

*Recurring royalty revenue*

 

We earn royalties under our licensing agreement with Sanofi-AventisS.A. for the active ingredient in Allegra/Telfast.  Royalties were as follows:

 

| **(in  thousands)**                   | ** ** |
|---------------------------------------|------------|
| **Three Months Ended March 31,** | ** ** |
| **2005**                              | ** ** | **2004** | ** ** |
| $                                     | 12,007     |   | $ | 9,992 |   |
|                                       |            |  |  |  |  |

 

The increase in royalty revenue for the quarter ended March 31,2005 was attributable to increased worldwide sales of Allegra/Telfast asreported to us by Sanofi-Aventis.  In theabsence of guidance from Sanofi-Aventis, we cannot predict future levels ofAllegra/Telfast royalty income.

 

***Costs and Expenses***

 

*Cost of contract revenue*

 

Our cost of contract revenue, from which we derive gross profit fromcontract revenue, consists primarily of compensation and associated fringebenefits for employees, chemicals, depreciation and other indirect projectrelated costs.  Cost of contract revenuefor our AMR and Organichem segments were as follows:

 
| **Segment**             | ** **   | **Three Months Ended March 31,** | ** **   |
|-------------------------|--------------|---------------------------------------|--------------|
| **(in  thousands)**     | ** **   | **2005**                              | ** **   | **2004** | ** ** |
| *** ***            | *** *** | *** ***                          | *** *** | *** *** | *** *** |
| AMR                     |         | $                                     | 10,704       |   | $ | 10,355 |   |
| Organichem              |         | 18,432                                |         | 13,508 |   |
| Total                   |         | $                                     | 29,136       |   | $ | 23,863 |   |
|                    |         |                                  |         |   |   |
| AMR Gross Margin        |         | 21.3                                  | %            | 26.4 | % |
| Organichem Gross Margin |         | 20.0                                  | %            | 19.3 | % |
| Total Gross Margin      |         | 20.5                                  | %            | 22.6 | % |

 

AMR had a contract revenue gross margin of 21.3% for the three monthsended March 31, 2005, compared to 26.4% for the same period in 2004.  The decline in gross margin largely resultedfrom the decline in contract revenues in relation to the fixed cost componentsof AMR’s contract business, competitive pricing pressures, and amortization ofthe Company’s chemical compound and natural product library inventories,partially offset by salary and benefit expense savings resulting from theclosure of the Mt. Prospect facility.  Organichem’scontract revenue gross margin remained consistent, increasing slightly to 20.0%for the three months ended March 31, 2005 compared to 19.3% for the sameperiod in 2004.  We expect the costsincurred in providing contract services for the remainder of 2005 to remainconsistent with the amounts incurred in the current quarter.

 

17

----

 

*Technology incentive award*

 

We maintain a Technology Development Incentive Plan, the purpose ofwhich is to stimulate and encourage novel innovative technology development byour employees.  This plan allows eligibleparticipants to share in a percentage of the net revenue earned by us relatingto patented technology with respect to which the eligible participant is namedas an inventor.  Currently, TechnologyDevelopment Incentive Plan award expenses consist of payments to Dr. Thomas D’Ambra,the Chairman, President, and Chief Executive Officer of the Company as the soleinventor of the patents for fexofenadine HCl, and are equal to 10% of the totalpayments received by us with respect to those patents.  The incentive award was as follows:

 

| **(in  thousands)**                   | ** ** |
|---------------------------------------|------------|
| **Three Months Ended March 31,** | ** ** |
| **2005**                              | ** ** | **2004** | ** ** |
|                                  |       |   |   |
| $                                     | 1,201      |   | $ | 998 |   |
|                                       |            |  |  |  |  |

 

The increase was attributed to increased Allegra royalties for 2005 ascompared to 2004.

 

*Research and development*

 

Research anddevelopment expense consists of compensation and benefits for scientificpersonnel for work performed on proprietary technology development, researchprojects, costs of chemicals and other out of pocket costs, and overhead costs.We utilize our expertise in small molecule chemistry, biocatalysis and naturalproducts to perform our internal research and development projects. The goal ofthese programs is to discover new compounds with commercial potential. We wouldthen seek to license these compounds to a third party in return for acombination of up-front license fees, milestone payments and recurring royaltypayments if these compounds are successfully developed into new drugs and reachthe market. In addition, research and development is performed at Organichemrelated to the potential manufacture of new products and the development ofalternative manufacturing processes.

Research and development expenses were as follows:

 

| **(in  thousands)**                   | ** ** |
|---------------------------------------|------------|
| **Three Months Ended March 31,** | ** ** |
| **2005**                              | ** ** | **2004** | ** ** |
|                                  |       |   |   |
| $                                     | 3,489      |   | $ | 7,880 |   |
|                                       |            |  |  |  |  |

 

The decrease in R&D expense during the three months ended March 31,2005 is primarily due to the fact that R&D expenses for the three monthsended March 31, 2004 include a $3.1 million charge recorded for theissuance of warrants to BMS in conjunction with the acquisition of intellectualproperty related to our central nervous system (CNS) research programs.  In addition, during the first quarter of 2005we began to take steps to reorganize our internal departments in order to havea more formalized and structured R&D business group, and we have begun tomore narrowly focus the scope of our research and development activities.

 

R&Dspending related to individual projects may fluctuate based on the results ofthose projects. Projecting expected project completion dates and anticipatedrevenue from our internal research programs is not practical at this time dueto the early stages of the projects and the inherent risks related to thedevelopment of new drugs.  Our internal centralnervous system program is our most advanced opportunity to generate revenue,and we expect that a significant portion of our 2005 research and developmentcosts will be incurred in the further development of this project.  We have selected two drug candidatesfrom the CNS program to proceed into toxicity and safety pharmacology testing, witha view to finalizing the selection of a compound or compounds with respect towhich we expect to subsequently file an Investigative New Drug (IND)application with the United States Food and Drug Administration (FDA) forpurposes of commencing human clinical trials, should continued biologicalevaluation remain favorable.  We expectresearch and development expenses to increase in the second half of 2005 as wecontinue to advance our central nervous system programs.  While we continue to invest in this program,we are also beginning to seek discussions to license this technology inexchange for a combination of up-front license fees, milestones and royaltypayments. In addition to our central nervous system program, the Company alsocontinues to utilize our proprietary technologies, including our biocatalysisand natural product capabilities, to further advance other early stage internalresearch programs in the fields of oncology, immunosuppresion and inflammation.

 

18

----

 

*Selling, general and administrative*

 

Selling, general and administrative expenses consists of compensationand related fringe benefits for marketing and administrative employees,professional service fees, marketing costs and all costs related to facilitiesand information services.  Selling,general and administrative expenses were as follows:

 

| **(****in thousands)**                | ** ** |
|---------------------------------------|------------|
| **Three Months Ended March 31,** | ** ** |
| **2005**                              | ** ** | **2004** | ** ** |
|                                  |       |   |   |
| $                                     | 6,452      |   | $ | 3,921 |   |
|                                       |            |  |  |  |  |

 

The increase in selling, general and administrative expenses for the firstquarter of 2005 is attributable to approximately $0.6 million in salary andbenefit expenses due to the addition of administrative and business developmentpersonnel, $0.4 million in professional fees related to our accounting and SarbanesOxley compliance services, and $0.3 million in administrative costs associatedwith our Singapore operations.  Inaddition, the Company incurred $0.3 million in additional facilities costsassociated with the classification of Mt. Prospect facility costs asadministrative while it is being held for sale and its corporate headquartersfacility, which opened in February 2004. The Company also incurred additional recruiting costs of $0.2 millionassociated with the hiring of executive management, senior scientificpersonnel, and the staffing of our Singapore operations.  The remaining increase relates to thereallocation of certain expenses to more appropriately reflect the current useof these resources.  We expect selling,general administrative costs to remain consistent with amounts incurred in thecurrent quarter for the remainder of 2005.

 

*Interest income (expense), net*

 

| ** **                     | ** ** | **(in  thousands)**                   | ** ** |
|--------------------------------|------------|---------------------------------------|------------|
| ** **                     | ** ** | **Three Months Ended March 31,** | ** ** |
| ** **                     | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Interest (expense)             |       | $                                     | (478       | ) | $ | (339 | ) |
| Interest income                |       | 678                                   |       | 500 |   |
| Interest income (expense), net |       | $                                     | 200        |   | $ | 161 |   |
|                                |            |                                       |            |  |  |  |  |  |

 

The increase in interest expense for the three months ended March 31,2005 was due to the capitalization of interest costs incurred during theconstruction of the Company’s headquarters facility in the first quarter of2004, as well as increases in the rates paid on the Company’s variable ratedebt that were not hedged by its interest rate swaps.

 

The increase in interest income was primarily due to increases in therates earned on interest bearing cash accounts and other short-term cash equivalents,as well as an increase in the balances held in these accounts of approximately$10.0 million or 8%.

 

*Income tax expense*

 

| **(in thousands)**                    | ** ** |
|---------------------------------------|------------|
| **Three Months Ended March 31,** | ** ** |
| **2005**                              | ** ** | **2004** | ** ** |
|                                  |       |   |   |
| $                                     | 2,962      |   | $ | 1,487 |   |
|                                       |            |  |  |  |  |

 

The increase in income tax expense for the three months ended March 31,2005 is due to the increase in pre-tax income from the prior year, as theCompany’s effective tax rate remained relatively consistent at 34.6% of pre-taxincome for the three months ended March 31, 2005 compared to 35.0% for thethree months ended March 31, 2004.

 

**Liquidityand Capital Resources**

 

We have historically funded our business through operating cash flows,proceeds from borrowings and the issuance of equity securities.  During the first quarter of 2005, wegenerated cash of $7.1 million from operating activities.  The primary sources of operating cash flowsare payments received for the performance of contracted chemistry services androyalty payments received from Sanofi-Aventis based upon a percentage of salesof Allegra/Telfast.  The primary uses ofoperating cash flows are the payment of compensation and benefits to bothscientific and administrative personnel, purchases of inventory and supplies,and payment of occupancy costs.  Asubstantial majority of the uses of operating cash flows pertain to the Company’sresearch and development and contract service business activities.

 

19

----

 

During the first three months of 2005, we used $0.8 million ininvesting activities, resulting from the use of $1.7 million for theacquisition of property and equipment, partially offset by net proceeds frominvestment securities transactions of $0.9 million.  During the first three months of 2005, weused $0.4 million for financing activities, consisting of $1.0 million inlong-term debt repayments, offset by $0.6 million provided by stock option andstock purchase plan exercises.

 

Working capital was $161.4 million at March 31, 2005 as comparedto $179.8 million as of December 31, 2004. The primary sources of the decrease were the reclassification of theCompany’s line of credit, which matures in February 2006 to a current liability, and an increase in income taxes payable due tothe accrual of estimated income tax expense on the Company’s pre-tax incomeduring the quarter.  These increases werepartially offset by an increase in cash and investments due to the collection ofAllegra royalty revenues, as well as an increase in accounts receivable due totiming of shipments to Organichem’s largest customer, GE Biosciences.  During 2005, we anticipate making $0.6million in defined benefit pension plan contributions, $0.3 million of whichwas paid in the first quarter.  Therehave been no significant changes in future maturities on our long term debtsince December 31, 2004, however, we are currently in discussions relatedto the extension of our line of credit for a term of five years.  We expect to complete the extension in thesecond quarter of 2005.

 

We entered into a credit facility consisting of $30.0 million term loanand $35.0 million line of credit to fund the acquisition of Organichem during2003.  The term loan matures in February,2008.  As of March 31, 2005, theinterest rate on $15.0 million of the outstanding term loan balance was 4.61%and the interest rate on the remaining $7.5 million was 3.81%.  The line of credit expires in February 2006and bears interest at a variable rate based on the Company’s leverageratio.  As of March 31, 2005, theoutstanding balance of the line of credit was $25.5 million and the interestrate was 3.76%.  The credit facilitycontains certain financial covenants, including a maximum leverage ratio, aminimum required operating cash flow coverage ratio, aminimum earnings before interest and taxes to interest ratio and aminimum current ratio.  Other covenantsinclude limits on asset disposals and the payment of dividends.  As of March 31, 2005 we were incompliance with all covenants under the credit facility.

 

The disclosure of payments we have committed to make under ourcontractual obligations is set forth under the heading “Management’s Discussionand Analysis of Financial Condition and Results of Operations—Liquidity andCapital Resources” under Item 7 of our 2004 Form 10-K. Excluding therepayment of $1.0 million outstanding under our credit facility, and $0.3million in defined benefit pension plan contributions, as described above,there have been no material changes to our contractual obligations since December 31,2004.

 

We are pursuing the expansion of our operations through internal growthand strategic acquisitions. We expect that such activities will be funded fromexisting cash and cash equivalents, cash flow from operations, the issuance ofdebt or equity securities and borrowings. Future acquisitions, if any, could befunded with cash on hand, cash from operations, borrowings under our creditfacility and/or the issuance of equity or debt securities. There can be noassurance that attractive acquisition opportunities will be available to us orwill be available at prices and upon such other terms that are attractive tous. We regularly evaluate potential acquisitions of other businesses, productsand product lines and may hold discussions regarding such potentialacquisitions. As a general rule, we will publicly announce such acquisitionsonly after a definitive agreement has been signed. In addition, in order tomeet our long-term liquidity needs or consummate future acquisitions, we mayincur additional indebtedness or issue additional equity or debt securities,subject to market and other conditions. There can be no assurance that suchadditional financing will be available on terms acceptable to us or at all. Thefailure to raise the funds necessary to finance our future cash requirements orconsummate future acquisitions could adversely affect our ability to pursue ourstrategy and could negatively affect our operations in future periods.

 

The recurring royalties we receive on the sales of Allegra/Telfast havehistorically provided a material portion of our operating cash flows.  As discussed in Part II, Item I of this Form10-Q, several generic manufacturers have filed ANDA applications with the FDAseeking authorization to produce and market a generic version of Allegra.  We and Aventis Pharmaceuticals have filedseveral patent infringement suits against these generic companies alleginginfringement of certain U.S. patents. Should we or Sanofi-Aventis be unsuccessful in defending these patentswe would experience a material decrease in operating cash flows.

 

**Critical Accounting Policies and Estimates**

 

Our discussion and analysis of our financial condition and results ofoperations are based upon our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States of America. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. On an on-going basis, we evaluate ourestimates, including those related to bad debts, inventories, intangibleassets, equity investments, unbilled revenue, income taxes and contingencies.We base our estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions.

 

20

----

 

We refer to the policies and estimates set forth in the section “Management’sDiscussion and Analysis of Financial Condition and Results of Operation —Critical Accounting Estimates” of our Annual Report on Form 10-K for the fiscalyear ended December 31, 2004.  Therehave been no material changes or modifications to the policies since December 31,2004.

 

Item3. Quantitative and Qualitative Disclosures about Market Risk

 

There are nomaterial changes in market risks since our annual report on Form 10-K for the yearended December 31, 2004.

 

Item4. Controls and Procedures

 

*DisclosureControls and Procedures*

 

As required byrule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), as of the end of the period covered by this Quarterly Report ourmanagement conducted an evaluation with the participation of our ChiefExecutive Officer and Chief Financial Officer, regarding the effectiveness ofour disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, werecognize that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and our management necessarily was required to apply itsjudgment in evaluating and implementing possible controls and procedures. Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that, as of the end of the period covered by this QuarterlyReport, our disclosure controls and procedures were effective in that theyprovide reasonable assurance that information required to be disclosed by us inthe reports we file or submit under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the Securitiesand Exchange Commission’s rules and forms. We intend to review and document our disclosure controls and procedures,including our internal controls and procedures for financial reporting, on anongoing basis, and may from time to time make changes aimed at enhancing theireffectiveness and to ensure that our systems evolve with our business.

 

*InternalControl Over Financial Reporting*

 

There were nochanges in our internal control over financial reporting that occurred duringthe period covered by this Quarterly Report on Form 10-Q that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

21

----

 

PART II - OTHERINFORMATION

 

Item 1.             Legal Proceedings

 

The Company, from time to time, may be involved in various claims andlegal proceedings arising in the ordinary course of business. Except as notedbelow in regards to litigation relating to Allegra, we are not currently aparty to any such claims or proceedings which, if decided adversely to us,would either individually or in the aggregate have a material adverse effect onour business, financial condition, results of operations or cash flows.

 

AMRTechnology, a subsidiary of the Company, along with Aventis PharmaceuticalsInc., a U.S. pharmaceutical business of Sanofi-Aventis S.A., are involved inlegal proceedings with several companies seeking to market generic versions ofAllegra. Beginning in 2001, Barr Laboratories, Inc., ImpaxLaboratories, Inc., Mylan Pharmaceuticals, Inc., Teva PharmaceuticalsUSA, Dr. Reddy’s Laboratories, Ltd./Dr. Reddy’sLaboratories, Inc., Ranbaxy Laboratories Ltd./Ranbaxy PharmaceuticalsInc., and Sandoz Inc. filed Abbreviated New Drug Applications (ANDAs) with theU.S. Food and Drug Administration, or FDA, to produce and market genericversions of Allegra products.

 

Inresponse to the filings described above, beginning in 2001, AventisPharmaceuticals filed patent infringement lawsuits against Barr Laboratories,Impax Laboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Ranbaxy Laboratories Ltd./RanbaxyPharmaceuticals Inc., and Sandoz. Each of the lawsuits was filed in the U.S.District Court in New Jersey and alleges infringement of one or more patentsowned by or licensed to Aventis Pharmaceuticals. Further, beginning in March 5,2004, AMR Technology, along with Aventis Pharmaceuticals, filed suit in theU.S. District Court in New Jersey against Barr Laboratories, ImpaxLaboratories, Mylan Pharmaceuticals, Teva Pharmaceuticals, Dr. Reddy’sLaboratories, Amino Chemicals, Ltd., Sandoz, Inc. and Ranbaxy LaboratoriesLtd./Ranbaxy Pharmaceuticals Inc., asserting infringement of two of our U.S.patents that are exclusively licensed to Aventis Pharmaceuticals relating toAllegra and Allegra-D products.

 

Inthe pending litigations, Aventis Pharmaceuticals and AMR Technology haveentered into covenants not to sue the defendants under U.S. PatentNo. 5,578,610, which patent has not been asserted in the litigation butwhich Aventis Pharmaceuticals exclusively licenses from us. However, we andAventis Pharmaceuticals have agreed that Aventis Pharmaceuticals will continueto pay royalties to us based on that patent under our original licenseagreement with Aventis Pharmaceuticals. Under our arrangements with AventisPharmaceuticals, we will receive royalties until expiration of the underlyingpatents (2013 for U.S. Patent No. 5,578,610 and 2015 for U.S. Patent No. 5,750,703)unless the patents are earlier determined to be invalid.

 

Under applicable federal law, marketing of an FDA-approved genericversion of Allegra may not commence until the earlier of a decision favorableto the generic challenger in the patent litigation or 30 months after the datethe patent infringement lawsuit was filed. In general, the first generic fileris entitled to a 180-day marketing exclusivity period upon FDA approval.  Barr Laboratories, Inc., a defendant in theongoing Allegra patent litigation, currently is eligible to market a genericform of Allegra; but, if it were to do so, it would risk damages for patentinfringement if the current Allegra patent litigation is not resolved favorablyto it.

 

22

----

 

Item 6.             Exhibits

 

(a)                      Exhibits.

 
| 10.1*  |   | Form of Restricted Stock Award Agreement under the 1998 Stock Option  and Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the Securities and Exchange Commission  on March 17, 2005 (File No. 000-25323) |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                 |
| 10.2*  |   | Form of Incentive Stock Option Agreement under the 1998 Stock Option and  Incentive Plan (filed herewith).                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                 |
| 10.3*  |   | Form of Non-Qualified Stock Option Agreement for Non-Employees under  the 1998 Stock Option and Incentive Plan (filed herewith).                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                 |
| 31.1   |   | Certification of the Chief Executive Officer pursuant to Rule  13a-14(a)/15d-14(a) of the Security Exchange Act of 1934.                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                 |
| 31.2   |   | Certification of the Chief Financial Officer pursuant to Rule  13a-14(a)/15d-14(a) of the Security Exchange Act of 1934.                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                 |
| 32.1   |   | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                 |
| 32.2   |   | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                     |

 

----

*                 Denotesmanagement contract or compensation plan or arrangement.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                     | ALBANY MOLECULAR RESEARCH, INC. |
|--------------------------|---------------------------------|
|                     |                            |   |
|                     |                            |   |
| Date:  May 10, 2005 | By:                             | /s/ Thomas E. D’Ambra, Ph.D. |   |
|                     |                            | Thomas E. D’Ambra, Ph.D. |
|                     |                            | Chairman of the Board, President and Chief Executive  Officer |
|                     |                            | (Authorized Officer) |
|                     |                            |   |
| Date:  May 10, 2005 | By:                             | /s/ Mark T. Frost |   |
|                     |                            | Mark T. Frost |
|                     |                            | Chief Financial Officer, Secretary and Treasurer

(Authorized Officer and Principal Financial Officer) |

 

23

----